The Necessity Retail REIT, Inc. (GNL) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us. This call is being webcast on the Investor Relations sections of GNL and RTL's websites at www.necessityretailreit.com and globalnetlease.com. Joining me today on the call to discuss the exciting transaction are Michael Weil, President and Chief Executive Officer at Necessity Retail REIT, and Jim Nelson, CEO at Global Net Lease. [Operator Instructions] As a reminder, this conference is being recorded. The following information contains forward-looking statements, which are subject to risks and uncertainties. Should one or more of these risks or uncertainties materialize, actual results may differ materially from those expressed or implied by the forward-looking statements. We refer you all to each company's respective SEC filings, including the annual report on Form 10-K for the year ended December 31, 2022, filed in February 2023, and all other filings with the SEC after that date, and contained in the presentation regarding the transaction posted to the Investors Relations section of GNL's website for additional risks and for a more detailed discussion of the risk factors that could cause these differences or otherwise impact our business. Any forward-looking statements provided during this conference call are only made as of the date of this call. As stated in SEC filings, GNL and RTL disclaims any intent or obligation to update or revise these forward-looking statements except required by law. Also during today's call, we will discuss non-GAAP financial measures, which we believe can be useful in evaluating the company's financial performance. These measures should not be considered in isolation or as a substitute to our financial results prepared in accordance with GAAP. Reconciliations of these measures to the most directly comparable GAAP measures are available in the Transaction presentation posted to the Investor Relations section of GNL's website. Please refer to the recent earnings releases for more information about what we consider to be implied investment-grade tenants, a term we may reference on throughout today's call. GNL and RTL also intend to file with the SEC a joint prospectus and proxy statement regarding the proposed transaction and investors are urged to read this document when it becomes available, because it will contain important information about the proposed transaction. I'll now turn the call over to Michael Weil.

Great. Thank you, operator, and good morning, everybody. I'm happy to be joined today by Jim Nelson, the co-CEO of what will be the merged GNL and also the CFO, Chris Masterson. Many of you know us in our current roles, and frankly, we're very excited about the announcement of this merger and coming together. The merged GNL will be the third largest publicly traded net lease REIT with a global presence. And one of the things that we're very excited about is just the overall scale of the company, the diversification, and frankly, a number of things that I plan on talking about on today's call and probably get into with the Q&A. I hope you have all had a chance to read the press release that was filed last night as well as the investor deck. There's a lot of pertinent details in both, and if you haven't had a chance, I do hope you will look through the decks as well. Let me get started. First of all, we announced a transaction, a stock for stock merger. GNL will be acquiring RTL. The RTL shareholders will receive 0.670 shares of GNL and as I mentioned earlier, this is going to be a very significant publicly traded net lease REIT with exposure of course not only in North America, but in Europe as well. The increase in size, scale, and overall prominence, this will be a $9.6 billion asset portfolio. The company will have over 1,350 individual properties, and we'll talk a little bit about some of the diversification that comes from that. We think about it in terms of geography, asset type, tenant, and industry. We have mitigated concentration risks. The top 10 tenants in the portfolio represent less than 20% of the overall straight-line rent, and our largest tenant in the portfolio, who is FedEx, represents 2.7% of overall straight-line rent. As we think also of the overall portfolio, 55% of the overall portfolio is investment-grade or implied investment grade rated. So again, from a credit standpoint, we think that the 2 companies coming together really adds a lot. For the shareholders, which of course they're at the forefront of our thoughts, we anticipate this to be 9% accretive compared to GNL's Q1 2023 AFFO per share, and that accretion comes from a number of things. It comes from the scale and it also comes from the internalization of management, which I'll discuss in just a few minutes. Net debt-to-EBITDA of the pro forma company is reduced to 7.6x, which I think is a very important starting point for both companies as the overall balance sheet is stronger of the merged company and really gives us a great foundation to continue to operate and grow the company. For dividend coverage, we expect an 85% payout ratio of the dividend that the Board anticipates to be setting at a $1.42 per share at time of closing, and that's been reviewed and based on the implied earnings of the overall portfolio. One of the things that is exciting about that is, for the existing RTL shareholders that will become GNL shareholders, that's going to represent a 12% increase in overall dividend for those shareholders that become GNL shareholders, and then just overall for the GNL shareholders. aA transaction that has alignment across the board, 9% accretion, I think is very meaningful and shows the value of these 2 companies coming together, and then when we take into effect the benefit of internalizing management. In this transaction, we will eliminate all management fees at closing. The employees that have currently been running both RTL and GNL will be internalized. They will come over and become employees of GNL. There will be no contracts between the former advisor and GNL. It will be a completely self-sufficient, internalized management structure that we're very excited about because of the familiarity and the skills of the employees that will be running GNL on a day-to-day basis. It will reduce operating expenses significantly. It will increase cash flow, which will be used for a number of things, everything from debt repayment, acquisitions, further potential increase in dividend coverage. And we looked, frankly, at the industry, and we have seen that internally managed peers traded about 14.3x AFFO compared to about 7.1x for externally managed net lease REITs. So again, I think that's just another reason that we really look to the benefits of this transaction. And we anticipate annual savings of $75 million through the internalization and merger synergies. From a corporate governance standpoint, the Board has taken the steps to enhance corporate governance. The decisions have been made to opt out of MUTA, something that I think from a governance standpoint, the market has inquired about. We will declassify the board at closing. And the company stockholder rights plan, many of you refer to that as a poison pill, will also be repealed. So very much an alignment -- further alignment between shareholders and the company. Before I stop for Q&A, or to see if Jim has anything that he'd like to add, as stated in the press release, there is a go-shop. RTL has a 30-day go-shop and that is being handled by their financial advisor, Truist, who represented RTL in this transaction. And on the GNL side, Bank of Montreal was the financial advisor. So Jim, Chris, before we go to Q&A, anything that you guys would like to add?

Yes, let me just say a couple of things, and thank you, Mike. First of all, I'm really looking forward to working with Mike and Chris. I mean, we've got 6.5 years already running this company and it's going to be a seamless transition, which is beautiful. And the scale will be something that's very, very exciting and important for GNL and the reduced expenses and internalization of management is really terrific. So, Mike covered a lot of the net takeaways, the value-add here, and I just want to emphasize that we at the company are really excited about this. So thank you, Mike.

Thanks, Jim. Chris, anything that you'd like to add or should we open up for Q&A?

We can open up for Q&A.

All right.

[Operator Instructions] Our first question comes from the line of Bryan Maher with B. Riley Securities.

Just a few for me this morning. Very interesting transaction. Can you share with us what prompted the merger at this particular time?

There were a couple of things that were really in our thoughts here. One, we just thought the combination made such great sense from a overall scale. And when the special committees were formed and they started to evaluate this, the information that they were provided by their financial advisors with the accretion, the dividend increase for the RTL shareholders, the overall value creation for the GNL shareholders, it just came to be very clear that this was going to be at almost $10 billion, a very meaningful transaction in creating a powerful net lease REIT that would benefit from scale. And then the conversations around internalization, just as an example, when we talked about internally managed peers trading at 14x AFFO and externally advised companies at 7x, we saw it as a good opportunity to really let the company find its true value with this scale. And so it -- timing just kind of happened naturally.

And then other than the internalization cost, the fee cost, what other costs are you expecting to merge the 2 companies together? Like how meaningful would that be?

The overall cost to merge the 2 companies will be very, very low. There will be details provided in the proxy when that is filed. Obviously, that's something that's -- that the work is already starting on. But because the 2 companies are familiar with one another coming from the common platform, internalization will be the driver. And in that internalization, GNL is going to be moving into fully furnished offices that already exist. There's not a need for employees to be hired, so the G&A that's been calculated and published in the press release and the decks takes that all into account. And when we talk about the 9% accretion in the overall deal, that factors in all costs. So it is a very positive overall transaction for the merged GNL.

Okay. One more for me and then I'll hop back into the queue and let the others go. The $1.42 dividend, I think, you said it was an 85% payout ratio on AFFO. I think the peers are at -- I don't know, I think in the deck I saw 75%. What gives you comfort with that 85% payout ratio and how comfortable should be the shareholders that there won't be a subsequent dividend cut in the next couple of years?

Well, I always caveat at, Bryan, by saying dividend policy is set by the Board, and management is very comfortable with where the Board came out at a $1.42 and the 85% coverage ratio. The pro forma company has taken into account a steady state merger between GNL and RTL. The $1.42 to us feels that it is the right sized dividend and 85% ratio will generate retained earnings that will be valuable to the company overall. And then when we think about the potential growth in the portfolio, everything from acquisitions, lease up, some strategic dispositions that occur, the Board will certainly have the ability over time to evaluate -- further improving the coverage ratio, but at 85% we feel that it is a very solid starting coverage ratio and a $1.42 is a justified dividend, so we were completely comfortable with the Board's decision on that reset.

Our next question comes from the line of Mitch Germain with JMP Securities.

So, Michael, in conjunction with closing, is it the understanding that you and Chris are going to resign from any other roles that you hold for any other reach that are in the AR Global organization?

Yes. That is absolute and it's been determined already.

How should I think about the growth prospects going forward? Obviously, RTL is facing some challenges on the tenant side with some bankruptcies. It does have some -- a pretty good leasing pipeline though. And then on the GNL side, obviously, you've got some office exposure. So how do I think about kind of your ability to grow earnings on a fairly steady consistent basis?

I think -- on the RTL side, I think your concerns are a little bit overstated. The portfolio has continued to show the ability to internally grow through lease up, et cetera. The other thing I would just point out is with the merged company, the further diversification of the portfolio adds a great level of additional safety, no tenant over 3%. So foundationally, we're very stable. Growth is an important aspect of running this company and that's something that we anticipate coming with more details on, in the future, as we get closer to a closing. What we wanted to do today was give the market a very clear picture of what day 1 merged GNL look like. And we're talking about -- I know, I've said it several times, and I guess I am intentionally trying to repeat it, but the proposed transaction is 9% accretive day 1, just from the combination of the portfolio, the known synergies from internalization, the removal of duplicate -- duplicative professional services like audit, et cetera. So, the company is really well positioned, I think, for continued growth, and we will be very eager to evaluate different opportunities to further grow through accretive acquisitions. There's a lot to come in this announcement. Obviously, this is day 1, but we're starting from such an exciting point. As you mentioned, RTL continues to perform at a very high level with lease up, as Jim and Chris can talk to. GNL continues to be very stable and they've had terrific performance with renewals and growth from that aspect. So there are a number of levers that we're excited to really develop and operate this company, so that it will have growth, not just in portfolio, but in earnings and AFFO.

You talked about some of the cost synergies, right? So $54 million seems to be pretty straightforward on the external advisement and property management side, but how should we think about the additional $21 million? That does seem a lot to think about when you consider audit, maybe some legal, some public filing fees. Like what comprises that and how should $21 million play out in terms of the realization of how quickly you can realize those synergies?

That additional roughly $20 million we project will be realized within the first year of the merger and it will be detailed in the proxy. The $75 million of annual savings that we've highlighted have been reviewed and vetted and Jim, Chris, and I are very confident, as you said, the majority of that comes from internalization. So, again, high level of confidence. There are not -- it's not a complicated synergies map to achieve these goals. So the $75 million is where we are comfortable and highly confident in achieving.

Last one for me. I know that you mentioned the go-shop, right? I think it's 30 days or so that you were handling, but I mean, was RTL for sale? Or was this just the situation that you've considered strategically today, and you'll see if the market has kind of any potential bids going forward? I mean, how should I consider how this process played out?

Well, again, Mitch, I'm going to rely on the details that will be published in the proxy for that, because this was handled -- both sides of this transaction were handled by special committees of the Board of the Independent Directors that I was not a part of. So the proxy will detail how this came about. And -- but I do think that a go-shop is a -- something that many deals have. It's a 30-day opportunity to see if there's a topper out there. And Truist is certainly capable of handling that process and we look forward to the outcome.

And is there a term fee if there is a higher bid? I didn't see that in the documents.

I didn't hear the beginning of your question. I apologize.

Is there some sort of fee that we need to consider if there's another bid?

I will have to confirm if that's been released yet. But I'm -- the details are all going to be provided, Mitch. I just don't want to get ahead of public disclosure.

Our next question comes from the line of Todd Thomas with KeyBanc Capital Markets.

Yes. A couple of questions. I guess, first, I just wanted to follow-up on the growth and the 9% accretion that you outlined at closing. Is that just related to the internalization transaction and corporate G&A synergies? Or does that also include assumptions around operations, leasing? You've detailed and discussed the Mountain Express bankruptcy a little bit and things of that nature?

So Todd, that 9% accretion takes into account, obviously, the synergies -- the $75 million of synergies. It also takes into account the known status of both the RTL and the GNL portfolios come together. It didn't -- there's no -- at this point in what's been publicly disclosed, there are no assumptions about growth other than what's in the company's existing pipelines.

And then can you discuss the internalization fee, the $325 million and $50 million amounts? A little bit of color on how that valuation was arrived at? And maybe for Chris, within the context around the pro forma 4Q estimate, how many shares are you assuming are outstanding at closing for that calculation?

Chris, do you want to respond or do you want me to start?

Yes, you could start. I'm just pulling the share information to make sure we put that out there.

Okay. Todd, I'm sorry, would you just restart your question for me? And I'll -- and Chris will jump in.

Yes. I just wanted to see if you could provide a little bit of color on how those amounts were arrived at in terms of the valuation for the internalization transaction?

I will. So first of all, Todd, the internalization amounts were negotiated. They will be detailed in the proxy. So I'm not privy to releasing the details of that at the moment, but there were -- each company, GNL and RTL had a advisory contract between AR Global and the REIT itself. And that was negotiated as part of the transaction, as was property management, which was another existing contractual arrangement. What the ultimate goal of the company GNL was, we wanted full internalization and separation, not for any other reason other than we wanted to be a clearly independent company operating our own portfolio, making our own contractual arrangements for anything that might be needed. But part of the employee group that will be coming over includes a full European asset management team, a U.S. asset management team. So the company will be able to run its own property management and asset management platforms. So -- but they were fully and heavily negotiated. And I think the acceptance of stock by AR Global as the majority currency in the internalization shows great alignment and belief in the announced transaction. And we were excited to see that structured the way it was. And we think AR Global did a great job as the external advisor. But we're excited to be fully internalized and operating the portfolio as -- in the same way that a lot of our internally managed peers are currently doing as well.

And just to jump in about the shares. So about -- we have not disclosed the number of shares as part of the internalization component. But for the RTL stockholders, it's 0.670 shares of GNL that they received. And there was about 134 million of shares outstanding as of the quarter end. So that's roughly about 90 million related to RTL.

And then just back to the $21 million of merger synergy. So -- just so I understand, you're expecting that to be fully realized within the first year of closing? I just wanted to make sure, because it sounds like there could be some leases or technology or vendor contracts and things of that nature. But you're anticipating the full $21 million to be realized in the run rate within 12 months of closing?

That is correct.

And then just one more. As we kind of think about the combined company going forward, do you plan to begin providing guidance as we think about 2024, whether full year '24 AFFO guidance, same-store growth and just more detail around the portfolio and assumptions going forward?

Final decisions haven't been made, but I think you can tell by what we've published regarding the merger and the accretion and things like that. I would -- I believe that yes, we will be providing some guidance.

Our next question comes from the line of John Massocca with Ladenburg Thalmann.

So I think going back to the internalization fee, can you just walk us through the math for the $325 million equity component? I mean, is that based on shares as of yesterday's close or heading into the merger? Just kind of -- any kind of detail as to how we should think about the share count number that's going to come out of that portion of the internalization fee?

I'm going to have to ask that we wait until the proxy is filed. That will all be part of the disclosure. It's just not out yet.

And then maybe kind of bigger picture, you're going to have kind of these 3 property type buckets: the retail side of things, the office and the industrial. Are you going to focus as you look to grow on any one particular property type or dispose off any one particular property type, or is it going to continue to kind of have these 3 verticals as you go forward?

Well, as we think about the 3 verticals, we think that they all have very valuable qualities. And with our office, the office is single tenant, mission critical corporate headquarters. So unlike a lot of the conversations we hear about the struggles of different cities and their multi-tenant office portfolios, these corporate office complexes continue to be typically at 100% occupancy with activity throughout every day -- every business day. So the portfolio complements itself. We look at some of the peer set. We talked about being one of the 3 largest net lease REITs with global exposure and fourth largest overall net lease. And when you look at that whole range of companies, they have very similar exposure, retail, office, industrial. We will continue to see different markets and different buying opportunities, different cycles, et cetera. And that will -- that's what Jim and I and the acquisition teams will continue to evaluate as we look at the portfolio and where we have different opportunities to grow.

And then it's kind of implied a little bit in your answer to Mitch's question, but I just want to make sure I'm thinking about this right. The $54 million of synergies that comes from the internalization, that should be relatively instant upon closing of the merger, correct?

Correct.

And then one last one. And I know this may come with the SEC filings, but any thoughts on timing for the shareholder votes for both RTL and GNL shareholders?

That will all be announced. It's being worked on. We were really glad to get this out into the market last night, host today's initial call. You'll be seeing, as is customary in a transaction like this, further updates and dates, et cetera. So that will be announced shortly.